Chapter 03 - Rational Consumer Choice

Chapter 3 Rational Consumer Choice

Answers to Questions for Review
1. You will be as well off as a year ago; your budget line will remain the same. Your real
income stayed unchanged.

2. False. The slope of the budget constraint tells us only the ratio of the prices of the two goods.

3. False. Diminishing MRS explains the convexity of the indifference curve, but not the
downward slope.

4. You prefer Coke to Diet Coke, Diet Coke to Diet Pepsi, but prefer Diet Pepsi to Coke.

5. The slope of an indifference curve indicates how much of a good one is willing to give up to
get one unit of another and be at the same level of satisfaction. Thus the more of one good
that one is willing to give up, the less important is that good relative to the other.

6. One bundle may be within the individual's opportunity set while the other is not (cannot
afford it).

7. If the relative price of the two goods is not the same as the slope of the indifference curve,
then one will always get a corner solution.

8. True. The corner solution (a) is on a higher indifference curve than the corresponding
tangency (b). Which corner becomes the solution depends on the slope of the budget

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constraint. There can be a solution in either corner, as shown in the graphs below. Quantity
discounts will not change this outcome scenario.

b
a
X

9. Suppose that Ralph's current consumption bundle is given by the point A in the diagram. The
information given tells us that on the budget with M+10 units of income, Ralph would
consume at the point B, and that B is equally preferred to C. This can happen only if the
indifference curve passing through B and C does not have the usual convex shape. His
indifference curve through B and C could, for example, be a straight line, indicating that tuna
fish and Marshallian money are perfect substitutes in this region. (If the indifference curve
through B and C were convex, then Ralph's optimal bundle would lie between B and C,
which means that he would spend some of the extra R100 on tuna fish.)
Y

M + 100
M

B
A

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Answers to Chapter 3 Problems

1.

2.

3. a) Pecans are equally preferred to macadamias, which are preferred to almonds, which are
preferred to walnuts, so by transitivity it follows that pecans are preferred to walnuts.

3. b) Macadamias are preferred to almonds and cashews are preferred to almonds. Transitivity
tells us nothing here about the preference ranking of macadamias and cashews.

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4. True . Each price increases by 15%, so that Px/Py is unchanged. (It is illustrated in the
graph, but it can be answered without drawing the graph.)
Y
M/80
M/92

slope = 120/80 = 3/2

Slope = 138/92 =3/2

M/138 M/120

5. a)
Y
150

60

Milk Balls

5. b) The opportunity cost of an additional unit of the composite good is 1/2.5 = 0.4 bags of milk
balls.

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6. a)

Y
150

100

60

Milk Balls

6. b) The opportunity cost of a unit of the composite good is now 0.6 bags of milk balls.

7. a)

Y
150

90 Milk Balls
7. b) The opportunity cost of a unit of the composite good is again 0.6 bags of milk balls.

8. a) To get any enjoyment from them, Picabo must consume skis and bindings in exactly the
right proportion. This means that the satisfaction Picabo gets from the bundle consisting of 4
pairs of skis per year and 5 pairs of bindings will be no greater than the satisfaction provided
by the bundle (4, 4). Thus the bundle consisting of 4 pairs of skis per year and 5 pairs of
bindings lies on exactly the same indifference curve as the original bundle. By similar
reasoning, the bundle consisting of 5 pairs of skis per year and 4 pairs of bindings lies on this
indifference curve as well. Proceeding in like fashion, we can trace out the entire
indifference curve passing through the bundle (4, 4), which is denoted as I1 in the diagram.

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Chapter 03 - Rational Consumer Choice

Skis (pairs/yr) 20
16

I4

12

I3

8
5
4

I2

I1
4

12

16

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20 Bindings (pairs/yr)

Chapter 03 - Rational Consumer Choice

b) Skis (pairs/yr)

20
16

I4

12

I3

I2

4
0

I1
4

12

16

18

20 Bindings (pairs/yr)

9. Picabo's budget constraint is B = 15 - 2S. Initially, she needs the same number of pairs of skis
and bindings S = B. Inserting this consumption equation into her budget constraint yields B =
15 - 2B, or 3B = 15, which solves for B = 5 pairs of bindings (and thus S = 5 pairs of skis).
As an aggressive skier, she needs twice as many skis as bindings S = 2B. Inserting this
consumption equation into her budget constraint yields B = 15 - 4B, or 5B = 15, which solves
for B = 3 pairs of bindings (and thus S = 6 pairs of skis). She consumes more skis and fewer
bindings as an aggressive skier than as a recreational skier. See graph below.

Pairs of Bindings per Year (B)

15
B = 15 2S

B=S
5
B = S/2
3
0

5
6
Pairs of Skis per year (S)

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10. Alexi's budget constraint is T = 75 - (3/4)C. Her perfect substitute preferences yield linear
indifference curves with slope equal to negative one, such as T = 75 - C and T = 100 - C. By
consuming 900/9 = 100 cups of coffee each month, she reaches a higher indifference curve than
consuming 900/12 = 75 cups of tea (or any affordable mixture of coffee and tea). Thus Alexi
buys 100 cups of coffee and no tea. Any increase in the price of coffee would force Alexi to a
lower indifference curve, and thus lower her standard of living.

Cups of Tea/month
(T)
100
T = 100 C
75
T = 75 (3/4)C

100
Cups of Coffee per month (C)

11. In the diagram, suppose we start at bundle A and then take away P units of pears. How
many more units of apples would we have to give Eve to make her just as happy as at A?
The answer is none, because she didn't care about pears in the first place, and therefore
suffered no loss in satisfaction when we took P units of pears away. Bundle B is thus on the
same indifference curve as bundle A, as are all other bundles on the horizontal line through
A. All of Eve's indifference curves are in fact horizontal lines, as shown.
Apples (kg/wk)

Increasing satisfaction

B A
P

Pears (kg/wk)
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12. Again start at a given bundle, such as A in the left panel of the diagram below. Then take
away a small amount of food, F, and ask what change in smoke, S, would be required to
restore Kamphelas original satisfaction level. In the standard case, when we take one good
away we need to add more of the other. This time, however, we compensate by taking away
some of the other good. Thus, when we take F units of food away from Kamphela, we must
reduce the smoke level by S in order to restore his original satisfaction level. This tells us
that the indifference curve through A slopes upward, not downward. Kamphela would be just
as happy with a smaller meal served in a restaurant with a no-smoking section as he would
with a larger meal served in a restaurant without one.
It is usually possible to translate the consumer's indifference curves into ones with the
conventional downward slope by simply redefining the undesirable good. Thus, if we might
focus not on smoke, an undesirable good, but on cleanliness (the absence of smoke), which is
clearly desirable. So doing would recast the indifference map in the left panel of the diagram
as the much more conventional-looking one in the right panel.

Food (kg/wk)

Increasing Satisfaction

I3
I2
I1

Food

Increasing Satisfaction

B
A
F

I3
I2

Smoke (micrograms/wk)

I1
Cleanliness

13. You prefer to maximize profit, which is the same under the two rate structures, making you
indifferent between them.

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14. a) The budget line is B1 and Paula will maximize her utility at the corner solution by attending
10 plays.

M ovies
36
30
24
21

B
0

15
B
1
5

10

12 Plays

14. b) If plays cost R120 and movies cost R40, the budget line is Bo, which has exactly the same
slope as Paula's indifference curves. She will be indifferent between all the bundles on B0.
14. c) On B1, she will consume 10 plays.

15.

Increasing
Y

satisfaction

Y
Increasing
Satisfaction

Garbage

Garbage

16. Let C = coffee (teaspoons/day) and M = Cremora (teaspoons/day). Because of Boris's

preferences, C = 4 M. At the original prices we have:
4M(l) + M(0.5) = 9
4.5M = 9
So M=2 and C=8

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Chapter 03 - Rational Consumer Choice

Let M' and C' be the new values of Cremora and coffee. Again, we know that C'=4M'. With
the new prices we have:
(4M')(3.25) + M'(.5) = 9
13M' + 0.5M' = 9, 13.5M' = 9, M' = 2/3
C = 8/3

17. An unrestricted cash grant would correspond to the budget B1 in the diagram. On B1 the
school would want to spend more than 2M on non-secular activities anyway, so the restriction
will have no effect. This result is analogous to the result in the text concerning the restriction
that food stamps not be spent on cigarettes. Provided the recipient would have spent more on
food than he received in stamps, such a restriction has no effect.

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Chapter 03 - Rational Consumer Choice

Non-secular Activities
14
12
10

B0

B1

8
6
4
2
0

10

18.

19 a) 10(0) + 10(2.50) = R25.00

19. b) 10(2.50) + 10(5.00) = R25 + R50 = R75.

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14

16 Secular Activities

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20. Your budget constraint is Y = 3 600 - 400C for 0 < C < 5 days of car rental (when you pay the
daily rate), constant at Y = 1 600 for 5 < C < 7 days of car rental (when you switch to the
weekly rate and thus additional days up to one week are free), and then Y = 1 600 - 400(C 7) = 4 400 - 400C for 7 < C < 11 (when again you have to pay by the day for each day
beyond the one week). a) If Y = 1 400C, then inserting this equation into the first leg of the
budget constraint yields 1 400C = 3 600 - 400C or 1 800C = 3 600, which solves for C = 2
days of car rental and thus Y = 2 800 worth of other goods. b) If instead you will trade a day
of car rental for R350, then you would consume a week's rental C = 7 and thus Y = 1 600
worth of other goods. Your seven days of car rental are equivalent to 7(350) = R2 450
according to your preferences, which when added to the R1 600 remaining, yields R4 050.
This beats the R3 600 if you consume no rental days and also beats the 11(350) = R3 850 if
you consume the maximum rental days you can afford (as well as beating any other
affordable combination of C and Y.

Composite Good
per trip (Y)
3600

Problem 20a
Y = 1400C
Y = 3600 400C

2800

Y = 1600
1600
Y = 4400 400C
0

5
7
11
Days of Car Rental per trip (C)

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Composite Good
per trip (Y)
3600

Problem 20b
Y = 4050 350C
Y = 3600 400C
Y = 1600

1600
Y = 4400 400C
0

5
7
11
Days of Car Rental per trip (C)

21. With diminishing MRS, to decrease pizza consumption from 3 to 2 slices, the consumer has
to be given more than 1 beer (since that was the amount needed to decrease pizza
consumption from 4 to 3 slices and stay on the same indifference curve). So he would be
indifferent between the bundles (3 slices of pizza, 2 beers) and (2 slices of pizza, X beers)
where X>3. However, we know that he prefers (1 slice of pizza, 3 beers) to (3 slices of pizza,
2 beers), so he should also prefer that bundle to (2 slices of pizza, X beers). But this violates
the more-is-better assumption.

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22. Budget set under Plan A:

Budget set under Plan B:

Notice that Plan A is superior to Plan B since its budget constraint is above the budget
constraint of Plan B.

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Chapter 03 - Rational Consumer Choice

23.
comp osite good

12

11

10

.
.
1

10 11 12 13 14 15 16

Quantity of Soft Drinks

Note that the budget constraint is not a line but rather the set of points that are shown in the
diagram and the ones that are below them. To construct this, for each level of composite
good, from 0 to 12, determine the maximum number of bottles you can buy with the leftover
money. For example, for composite good = 4 units, you have R80 left. The best you can do is
1 large and 1 small, which gives 11 tickets. Remember that you can't buy a fraction of a set.
Notice that point (0, 12) is also on the budget constraint.

24. Assume that the quality of the food is the same in both restaurants, so that price is the only
difference that matters to consumers. In the first restaurant, the R150 flat tip is a fixed cost: it
does not affect the cost of additional items ordered from the menu. In the second restaurant,
by contrast, the price will be 15 per cent higher for each extra item you order. The marginal
cost is higher. The average food bill is R1 000 in the first restaurant, which with tip comes to
R1 150. The same amount of food would cost the same in the second restaurant. But because

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the cost of each additional item is higher there, we expect that less food will be consumed in
the second restaurant. Note the similarity of this problem to the pizza experiment described in
Chapter 1.

25. Bo is Plane's budget constraint last year. By selling all his grapes he would have an income of
R140 000. By spending all his income on grapes he would have 7000 bu. This year's budget
constraint is B1. It starts at 16 on the Y axis and hits the grapes axis at 16/3, passing through
Y = 10, G = 2, last year's bundle. Since last year's indifference curve (ICo) was tangent to B0
at Y = 10, G = 2, and since this year's budget constraint is steeper than last year's, we know
that some part of last year's IC lies within B1. In particular, a part of ICo that lies above Y =
10, G = 2 is within B1. This means that Plane will consume more Y and less grapes than he
did last year. (See graph on next page.)

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Chapter 03 - Rational Consumer Choice

Y (1000s)
16
14

10
IC0
B1
2

B0
5.33

7 Grapes (1000 bu/yr)

26 Solve the budget constraint, 100 = 4X + l0Y, to get Y = 10 0.4X, then substitute into the
utility function to get U = X(10 0.4X ) = 10X 0.4X2. Equating U/X to zero we have
10 0.8X = 0, which solves for X = 12.5. Substituting back into the budget constraint and
solving for Y, we get Y = 5.

27 The result of solving the budget constraint for Y and substituting back into the utility function
is now U=X1/2(10 0.4X)1/2.

U / X = (1/2)X-1/2(10 0.4X)1/2 + X1/2(1/2)(10 0.4X)-1/2( 0.4) = 0

Rearranging terms, we get (10 0.4X)/X = 0.4, which solves for X = 12.5. Plugging back
into the budget constraint, we get Y = 5. Thus the optimal bundle is (12.5, 5), the same as in
problem 26.

28 Note that the utility function in Problem 26 is simply the square root of the utility
function in Problem 27. Since the square root function is an increasing function, it follows
that the values of X and Y that maximize utility in Problem 26 will also maximize utility in
Problem 27.

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29 Since we are given the marginal utility per last rand spent on each good, the prices, per
se, do not matter. If Sue spent R1 less on clothing and R1 more on food, her total utility
would change by 9 +12=3. So, no, she cannot be maximizing utility.

30 For Albert to be a utility maximizer, he must allocate his allowance so that the extra
utility per dollar is the same for both the last CD he purchased and the last movie he rented.
As shown in the table, this condition is satisfied when he purchases 2 CDs and rents 3
movies. And since this bundle costs exactly his weekly allowance (2x20 + 3x15 = 85), he is
maximizing his utility.

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Chapter 03 - Rational Consumer Choice

U(N)

MU(N)

MU(N)/PN

M U(M)

MU(M)

MU(M)/PM

__________________________________________________________________
0

0
60

3
20

140

3-21

60

30

15

195

1
4

165

120

105
105

100
20

60
40

210